Market Place; Buyout Firm Is Betting Wall Street Is Wrong

By FLOYD NORRIS

Published: September 13, 1994

Borden Inc. may be the most despised big company around. Its stock has fallen sharply amid talk that no one would buy its badly managed collection of businesses, ranging from the milk that made it famous to Cracker Jacks and Prince pasta. So why would someone buy it?

But yesterday, Kohlberg, Kravis, Roberts & Company did, serving notice that it thinks the conventional wisdom is very wrong.

Just what Kohlberg, Kravis sees in Borden is not completely clear. Kohlberg, Kravis officials will not speak publicly about the plan.

But it evidently believes that Borden, at its current price, is incredibly cheap, as well as a good way for Kohlberg, Kravis to reduce its disappointing investment in RJR Nabisco. It accomplishes that goal by paying current Borden holders not with cash but instead with RJR stock.

Whether Kohlberg, Kravis has bet wisely may not be clear for years. For while it is buying Borden at a low price, based on a multiple of revenues, it is also getting a business that has had a lot of trouble making money. The dairy business, in particular, is widely sneered at by Wall Street analysts. It is far from clear what should be done, but Kohlberg, Kravis will -- at least for now -- be keeping current management at Borden. Almost all Borden holders will be selling at a loss if this deal goes through.

Much has been made of Borden's admission that it tried to sell itself last year, and found no buyers. But it might be noted that during 1993 the stock traded as high as $29.125 a share, and at a low of $14.375. And any buyer presumably would have been expected to pay a premium.

But Kohlberg, Kravis, while it is paying a premium over recent share prices, is offering only $14.25 a share in RJR stock. Yesterday, Borden shares rose $2, to $13.625.

In buying Borden, Kohlberg, Kravis is using as currency a part of its stake in RJR Nabisco, the largest leveraged buyout ever. Whatever else the merits of the deal, it is reducing by about half -- and perhaps as much as 59 percent -- its exposure to a stock that has been a highly disappointing performer.

RJR Nabisco has not been a loser for Kohlberg, Kravis, as it has for public investors. The public got into the party when the company sold stock at $11.25 a share in 1991. Kohlberg, Kravis, on the other hand, invested $3.2 billion of funds it manages in RJR in 1989 and 1990, paying an average of about $5.60 a share. Yesterday, the shares closed at $6.625, down 37.5 cents. That small rise over more than five years has been a big disappointment for the investors who provide money for Kohlberg, Kravis.

RJR Nabisco will put up about $500 million in new common stock -- valued in a way not yet disclosed -- and for that will get a 20 percent stake in Borden, with a possibility of raising that to 30 percent later. The plan is for Borden to find some way to get cash from that stock -- perhaps by issuing Borden preferred stock convertible into RJR shares.

If it did that, Borden would get cash it could use to cut its heavy debt load.

In that way, this deal is a radical departure from the typical deal for Kohlberg, Kravis, which grew to be rich and famous by buying companies with only a little money for equity, coming up with the rest of the money by borrowing on the acquired company's own credit. When it worked, Kohlberg, Kravis could eventually sell the company for a huge profit. When it didn't, the enterprise filed for bankruptcy.

But this deal could leave Borden with less debt, not more.

While one might expect RJR Nabisco and Borden to be talking synergy between their various brands and market penetrations, the opposite is the case. The line yesterday was that this was a financial investment for RJR, and that no merging of operations, or even cooperation on the operational level, was anticipated.

The normal way for Kohlberg, Kravis to cash out of deals has been to sell stock to the public. But the RJR deal, in part because of its prominence, has been a hard one to get out of. Until now, Kohlberg, Kravis has sold no stock and RJR has paid no dividends on its stock. The firm has come up with a couple of innovative financing plans that involve RJR selling securities to the public in ways that would enable the company to start paying dividends, and in one case separate the investments in food and tobacco operations of the company.

But investors have been reluctant to bite, and Kohlberg, Kravis has been unable to get any cash.

This gambit does not bring in cash, but it does bring in a new company and reduce the dependence of Kohlberg, Kravis, and its performance figures, on RJR stock. A negative, however, is that it is likely to put RJR stock under renewed pressure -- from Borden holders cashing out of an investment in a company they did not buy and from others who conclude that Kohlberg, Kravis, with the inside knowledge that comes from controlling RJR, wants to reduce its exposure.

Under the merger deal, Borden shareholders will get RJR stock worth $14.25 a share, so long as RJR stock trades in a range of $6 to $8 a share during a 10-day period before the deal closes.

If RJR stock trades above that range, Kohlberg, Kravis will end up parting with 251 million of its 567 million RJR shares. If it falls below $6, Kohlberg, Kravis would give up 335 million shares.

Given that fans of both Borden and RJR Nabisco have suffered a lot of disappointments -- and underperformance -- in recent years, an old Wall Street joke comes to mind, with a slight alteration.

"Did you hear?" asked one investor. "I sold my one of my dogs for $1 million."

"Wow," said his friend. "For cash?"

"No," replied the first. "I got two $500,000 cows in trade."

It will be up to Kohlberg, Kravis to prove there was value in those cows that others on Wall Street could not see.